Private equity refers to a range of financial firms that restructure companies privately before selling them. While private equity firms may or may not buy and sell public companies, the companies are private entities during the restructuring process.

Private Equity, Buyouts and Leverage

Private equity firms have developed a somewhat notorious reputation for buying vulnerable companies, often through hostile means, loading them up with debt and then selling them at inflated prices.

As true or untrue as this characterization may be in general, it does fail to account for the huge range of restructuring expertise that exists in the private equity world.

Many private equity firms will, for example, take medium sized businesses struggling under the limitations of their current ownership and/or management and introduce a suite of professional managers with experience in breaching the gap between medium and large scale business operations.

Private equity firms are also often able to rely on their reputations to bring technical specialists in relevant fields on board in situations where they would otherwise be reluctant to work with a company on technical matters, such as proprietary scientific research.

While much of the private equity industry is dominated by the simple formula of restructuring existing companies with high amounts of debt to ‘juice’ their valuations before a resale, this is far from the full extent of the private equity industry.

Investing in Private Equity

Due to the nature of the private equity business and how they deploy their capital to buy and hold companies for extended restructuring periods, private equity firms tend to look to institutional investors and high net worth accredited investors that are willing to agree to long lock-in periods for their funds.

While private equity returns are some of the highest in the investing world, and are generally non-cyclical, these firms tend to charge extremely high fees that can outstrip the fees charged by even the most exclusive hedge funds.

That said, investments in private equity firms have continued to grow at a rapid pace over the last few decades, and they are increasingly taking on capital that was once allocated to hedge funds.

Trading and Private Equity

Day traders can create profitable positions in the equity and bond markets by tracking the operations of private equity firms. Private equity firms will often make their acquisitions and sales directly in the public markets, and the debt of the restructured entities will often be traded in secondary markets as well.

The kind of price action that surrounds private equity activity falls generally under the category of merger arbitrage, where corporate activity in the public markets is tracked to identify profitable trading opportunities.

Merger arbitrage trading carries its own unique features and is generally a form of fundamental analysis, though the resulting price action can often be analyzed in technical terms.

Final Thoughts

While most day traders will have little direct interaction with private equity firms, the activity of private equity firms in the public markets can create numerous profitable trading opportunities for day traders who are tracking private equity activity and understand the nuances of merger arbitrage trading.